ECB’s QE plan is full of risks for Europe

ECB’s QE plan is full of risks for Europe

Markets and many European politicians had been waiting a long time for European Central Bank President Mario Draghi to announce that the ECB’s monetary policy could include buying sovereign bonds if the situation deteriorates. The era of quantitative easing in Europe is not too far away, writes Dr Emmanuel Martin.

But would it solve Europe’s economic woes?

The idea of QE is that by purchasing sovereign debt, the ECB would give banks more room to lend to the economy. It would also release pressure from some governments in difficulty, giving them more room to manoeuvre.

One of Europe’s many problems is that despite apparently loose monetary policy with super low interest rates, its monetary situation is actually quite tight with money supply not growing. The transmission mechanism of monetary policy is broken.

The main reason is that banks have to lend more prudently and less, given new regulations and stress tests. Sluggish growth and negative projections, which make many private projects more risky, do not encourage them to lend more.

The banks are encouraged to re-make their margins on markets and to lend safely to governments.

So would QE change this when rates are already low and previous purchasing programmes have been unsuccessful?

It should be no different with a QE. Money growth will not pick up that easily.

Targeting QE in countries where it is most needed in the eurozone represents a technical obstacle to its effectiveness.

European countries also need to restructure their public finances at the same time, as years of ‘stimulus’ spending have left giant gaps in their finances. Austerity policies would certainly go against QE and destroy the supposed ‘stimulus’ effect.

QE offers more moral hazard for reform-resistant countries such as France and more bubbles on certain markets. Getting out of a QE is complicated too.

Mario Draghi is well aware of this. Hence his constant and pressing calls for structural reforms from governments to accompany his policy.

But Mr Draghi had to go further after his pledge to do ‘whatever it takes’ to save the euro two years ago. He had to make the system ‘hold’ a little longer with a QE announcement given the current negative outlook.

Perhaps he is hoping his announcement will make an impact and he never actually implements QE because the situation will improve.

But his QE announcement just amounts to trying to postpone the moment of truth.

Then a QE would only be launched if a major risk of break-up (with France defaulting for example) actually happened. The announcement can thus also been perceived as an “insurance” for investors. Again, moral hazard is generated.

Europe needs more free market reforms to unleash growth and serious reforms in government spending and bureaucracy in many countries.

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